Those low-fare, low-cost US airlines still standing as the year draws to a close may well wish to take a bow. In sharp contrast to the US majors, for them 1997 will have been a year of survival rather than profitability.
For the low-cost airlines that are limping towards the 1997 finishing line, there remains uncertainty about their prospects for 1998. As one observer remarked after looking at the sorry list of financial figures clocked up by the low-costs this year: 'You think to yourself, oh dear, they're not planning on much of a Christmas party, are they?'
In a desperate bid to improve the odds post-New Year's eve, in recent months several airlines have adopted new strategies and tactics, and even new identities. The budget-conscious business traveller has become a key target and many low-costs are revamping their images in an effort to be more appealing to this type of customer. Acquiring mass through mergers has become another favourite strategy - although not all are impressed by this. Morten Beyer, chairman and chief executive officer at Washington DC-based consultants Morten Beyer & Agnew (MBA), has likened them to 'pairs of drunks staggering down the street trying to hold each other up'.
But for those that are planning still to be around in 1998, help could be at hand from an unlikely source - the US government. Alarmed by the disastrous downturn exhibited by the low-costs over the last 18 months, the US Department of Transportation has finally acknowledged what many had already forecast: low-cost competition could be in danger of disappearing altogether. The DOT now promises to be more proactive in ensuring that an environment exists in which low-cost competition can operate. The Department of Justice, meanwhile, will work with the DOT to produce a better definition of what predatory practice is and says it will develop a clear enforcement policy for the industry. Senior congressmen are even stepping forward in support of the idea that the DOT become more vigilant in addressing anticompetitive behaviour, prompting some major carriers to shout warnings of reregulation.
The low-cost airlines themselves, however, are not simply waiting for the DOT to turn its words into actions. While they welcome some form of governmental intervention to redress a situation which they feel has been imbalanced since the ValuJet accident in May 1996, few are counting on this for their survival.
Earlier this year, the startup airlines formed their own lobbying organisation, based in Washington, to bring their issues to the political forefront. Edward Fabermann, executive director of the Air Carriers Association of America, welcomes the statements by the DOT, but remains cautious. 'It is good news, but it is still very slow moving,' he says. 'We are hopeful that this will lead to action, which is what is really needed. Talk is great, but it's action which is important.'
The need for action has been highlighted by consultants MBA in a review of the financial results of 30 smaller passenger airlines for 1995 and 1996. MBA says the results are 'frightening, to say the least'. In 1995, the group was largely profitable, with 11 airlines reporting net profits of $121.4 million and a net industry gain of $55 million. In 1996, 21 airlines logged losses of $223.9 million, while just five made a combined profit of $27.5 million, resulting in a total net group loss of $196.4 million - a net negative swing of a quarter of a billion dollars.
The first quarter of 1997, when most of the majors were reporting record profits, was even worse. Of 16 small airlines analysed, MBA found revenues for the group declined by almost $80 million, or more than 16 per cent. While the group managed a $1.6 million profit for the first quarter of 1996, by 1997 that had turned into an $87 million loss. In the past 18 months four airlines - Air South, Rich, Sun Jet and Viscount - have ceased operations, Great American has been shut down by the Federal Aviation Administration, and Western Pacific has entered Chapter 11 bankruptcy.
The majors point to poor management as the root cause of many of these tales of woe, but Beyer sees it differently. 'The catastrophic losses being experienced by this segment of the industry are due to structural problems of the industry and the big airlines' aggressive competitive practices,' he says. 'You now have ruthless competition when the new guy comes in and the big guys match fares identically, then as soon as they are blown away the fares go back up again.'
The low-costs themselves are not short of examples of the fierce competition they have found themselves pitched against, but they also list other key problems that they have faced since the ValuJet crash. First is the new stance by the FAA, which now scrutinises every startup proposal so thoroughly that almost none make it through the paperwork. Even if an airline gets off the ground, its rate of growth is severely controlled by the FAA. Second is the loss of faith by the public, which has continued to look on the startups with unease ever since the ValuJet crash.
Of all the combinations that have been attempted or talked about this year, that between ValuJet and AirTran Airways is the most obvious example of how a merger is being seen as the best hope for overcoming both these hurdles. Through this merger, the two airlines will gain critical mass at a speed no longer possible as individual airlines. Meanwhile ValuJet, which now operates as AirTran Airlines, sheds a name that will forever be linked with a tragedy in a Florida swamp and questionmarks against its management.
The newborn AirTran, with a new management team at the helm, has made some strategic decisions that are fundamentally different from those of no-frills ValuJet. From 22 November, the airline began offering a business-class cabin and preassigned seating to all full-fare economy passengers. The airline is also participating in computer reservation systems for the first time. Ponder Harrison, AirTran Airlines' senior vice president of marketing, says it would have been a 'recipe for disaster' not to have changed, even though the airline will retain its low fares.
With an audacity that left the FAA gritting its teeth, the two airlines have merged to combine resources and reap joint cost savings, but will retain separate operating certificates as Orlando-based AirTran Airways and Atlanta-based AirTran Airlines. By the end of the first quarter of 1998, the new holding company, AirTran Holdings, expects to have at its disposal a fleet of 50 McDonnell Douglas DC-9s and Boeing 737s serving almost as many cities. For the first time since it was grounded, the former ValuJet again has a commanding presence.
But Harrison insists that AirTran is a 'more solid and traditional' product. 'Over the last 12 months, this airline has gone through significant upheaval with changes on the management side and operations side,' says Harrison. 'By any statistical measure, if you now compare this carrier with any other carrier, then this airline is now right at the top of the stack. We knew we had to get that right first before we could invite the customer back. The merger was not done as a means to eradicate the name, but the merger made very, very good sense because of the ability to create mass as a niche player. It spreads the pain and forces the majors to reconsider.'
Management challenge
The key to success in 1998, Harrison believes, will lie in preserving the significant cash sums that ValuJet had built up while being flexible to the new marketplace. 'What the consumer wants has changed. The regulatory environment has changed. How do you navigate that course, growing again but not diminishing your cash reserve, and reinventing yourself? That has been the management challenge and the key is flexibility.'
The decision to go into CRSs is an example of that flexibility, says Harrison. 'ValuJet was viewed as the Darth Vader of the agencies,' says Harrison. 'But this is business, it is not religion. So many people make decisions that become etched in stone, but we say nothing is sacred and we want to do our best for our shareholders and for our customers.'
Most analysts view the AirTran merger as the best bet for each airline given the circumstances, although some wonder how long it will take to woo the business traveller. They are less certain, however, of the prospects for the merger of Pan Am and Carnival Airlines which took place in late September.
FAA restrictions
Pan Am was reborn last year as a low-cost, low-fares airline based in Miami. It was the project of Martin Shugrue, the former chief operating officer of the original Pan Am. It has been a rough 12 months for both airlines, with each accumulating heavy losses and Shugrue unable to grow Pan Am as he had originally planned because of the FAA restrictions. Strong competition on US transcontinental routes forced the partners to pull out of the Los Angeles market and concentrate instead on north-south routes along the US east coast. The newly merged airline, now known as Pan Am, has cut jobs by about 20 per cent to the current 1,750 headcount.
Yet Shugrue is now seeking a fresh injection of capital and remains confident that the merged company can achieve what the two airlines could not - profitability. 'Carnival was a true provider of low-cost seats, but it was lacking a strong airline brand,' says Shugrue. ' Yes, we at Pan Am have had more problems than were anticipated. What was most frustrating for Pan Am was dealing with the post-ValuJet regulatory environment. It took too long to get certificated and too long to get airplanes added to build up mass. This merger gives us critical mass.'
Shugrue says his original strategy for Pan Am remains in place. The Carnival aircraft will be refurbished to include a business-class cabin, services will be upgraded to meet Pan Am's meal-on-every-flight promise, and Shugrue will continue to seek international partners to feed his airline through codesharing, mainly with overseas passengers heading for the Caribbean. In readiness for 1998, Shugrue says he is stabilising the network, taking out those things that 'won't or can't work', planning to add more aircraft and step up frequencies, and adding Boston as a destination from 16 December. Beyer is sceptical. 'I don't see it,' he says. 'It puts them both even deeper into the red and their costs are way out of line.'
No need to wait until 1998 to see if another planned merger among the low-costs will improve the fortunes of each airline involved.
Frontier Airlines and Western Pacific, both based in Colorado, called off their deal just days before WestPac filed for bankruptcy. The corporate cultures at each airline were too different for the companies to have been successfully welded together, regardless of WestPac's cash crisis, say most observers.
The airline managers themselves seem to acknowledge this, with Frontier management hinting that the width of culture gap was not apparent until the two teams tried working together.
Still, that leaves Frontier with the problem of how to grow. The airline has 13 B737s with another expected in January, but would like a fleet of around 25 aircraft to stand up to competition. The merger would have created a combined fleet of 35 737s - a 'tempting prospect', says Frontier's marketing director, Bob Schulman. Frontier is now actively looking at other ways to acquire that mass. Another merger deal is unlikely, however.
For Kansas City-based Vanguard, mergers are not the route to survival. 'The reality is they are not easy to pull off,' comments the airline's vice president of marketing and planning, Russell Winter. The airline's third anniversary falls on 4 December, but the company has made major changes in the last few months in an effort to make sure there is something to celebrate. 'A few airlines are still waiting to see what the DOT might bring in, but we would agree with the AirTran strategy that you make your own luck,' says Winter.
Vanguard has had to rid itself of a 'charter airline image' that provided scruffy aircraft and unreliable service, says Winter. Post-ValuJet, the public has a totally different perception of the low-cost airline and it was essential for Vanguard to upgrade its image, he adds. The airline has ten B737-200s and is negotiating for an eleventh. On 17 December, it plans to launch new services which it hopes will attract the business traveller, from Pittsburgh to Chicago and New York, and from New York to Atlanta. Although these are strong business routes that the majors like to defend, Vanguard is banking on being left alone if it goes in gently. 'It's a massive assumption,' admits Winter, 'but I think they have bigger fish to fry.'
Blatantly obvious tactics
Winter might consider having a chat with the managers at Pro Air. Although just two aircraft strong, this airline says efforts to put it out of business have 'stepped across the line' since it began operating out of Detroit City Airport in July. Craig Belmondo, the airline's president and chief operating officer, says informal discussions have begun with the DOT about the 'blatantly obvious' tactics that are being used against Pro Air. 'You can go right down the laundry list,' he says.
Still, Pro Air is riding on a wave of support from local businesses in a city that previously was among the top three in the US for the highest airfares. 'Businessmen here have been exasperated,' says Belmondo. Pro Air management decided to lease new 737-400s to attract those business travellers. 'It's not just about perception, it's about operating costs and reliability. Reliability is critical when you only have two planes and passengers whose business depends on you. You can't settle for 95 per cent reliability - that 5 per cent just kills you. We think it's a huge issue.'
Pro Air also participates in CRSs, but has stayed away from preassigned seating in order to maintain fast gate turnarounds. Belmondo says he is optimistic for next year because '. . . the story is compelling.' Some 7 million people live in the Detroit catchment area and people are prepared to drive 150 miles or more to get a walk-up, one-way fare to New York for $79 when they used to pay $400. 'We continue to be buoyed up by the response we see in the marketplace,' he says.
Perhaps this story could take a happier turn for the low-cost carriers after all. But US regulatory help in rewriting the next chapter will prove vital.
Source: Airline Business
